When There Is Ambiguity In Arbitration Agreement, Business Efficacy Test Can Applied To Discern Intent Of Parties To Arbitrate: Bombay High Court

Brief Facts:

The present petition has been filed under section 11 of the Arbitration and Conciliation Act, 1996 (Arbitration Act) seeking appointment of an Arbitrator.

A Hotel Franchisee and Management Agreement (“Resort Management Agreement”) was executed on February 10, 2021 between the Petitioner-Applicant, Lords Inn Hotels and Developers Private Ltd. (“Lords Inn”) and Respondent No. 1, Pushpam Resorts LLP (“Pushpam”).

Disputes and differences arose between the parties. Pushpam issued a termination notice on October 8, 2024, terminating the relationship with effect from December 15, 2024. Lords Inn replied through a letter from its advocates on October 26, 2024 setting out the various breaches on the part of Pushpam under the Resort Management Agreement, demanding that the termination notice be withdrawn.

On November 26, 2024, Pushpam replied through its advocates, dealing with Lords Inn's contentions and reiterated the demand that Lords Inn vacate the premises by December 15, 2024. These exchanges were preceded by e-mail correspondence from each party, alleging various shortcomings attributed to the other party.

By a letter issued on December 7, 2024, advocates of Lords Inn pointed to a provision that dealt with a lock-in period, and invoked arbitration under Article XXIV of the Resort Management Agreement. By a letter issued on December 12, 2024, Pushpam replied stating that there is no valid arbitration agreement in conformity with Section 7 of the Arbitration Act.

Contentions:

The petitioner submitted that the reference to arbitration as contained in Article XXIV is a sufficient indication that the parties had intended to adopt arbitration as the means of resolution of disputes between them under the Resort Management Agreement.

It was also argued that the Resort Management Agreement is a commercial document that is not a standard form instrument and one must further business efficacy.

It was argued that applying the business efficacy test would subserve an alternate dispute resolution forum chosen through party autonomy with a fast track redressal of disputes and limited scope of judicial intervention.

Per contra, the respondent submitted that Article XXIV of the Resort Management Agreement does not envisage making a reference to arbitration. It is a clause that provides for governing law and jurisdiction, and provides that the jurisdiction of courts of Mumbai would be subject to a clause on arbitration, but there is actually no arbitration clause in the Resort Management Agreement.

It was also argued that if extrinsic evidence outside Article XXIV is to be considered, such conduct of parties too would have to be considered to truly examine business efficacy in resolving any perceived ambiguity about consent of the parties to resort to arbitration.

Observations:

The court observed that as per section 7(4) of the Arbitration Act, an arbitration agreement would be considered in writing if it is contained in a document signed by the parties or in exchange of letters or other means of communication which includes electronic communication.

Furthermore, the court observed that under Section 7(5), a reference in a contract, to a document containing an arbitration clause would constitute an arbitration agreement, if the contract is in writing and the reference is such as to make that arbitration clause a part of the contract.

The court after perusing the relevant clauses of the Resort Management Agreement observed that there is an ambiguity in the agreement as to whether any dispute arising between the parties can be referred to Arbitration.

In such cases where there is an ambiguity in the agreement, the court observed that the business efficacy test can be applied to discern the true intent of the parties to arbitrate.

The court noted that while applying the business efficacy test, it must conclude that the implied term is reasonable and equitable, necessary for business efficacy, implicitly agreed upon (officious bystander test), clearly expressed, and consistent with the express terms. Once these conditions are satisfied, the court may infer the implied terms. However, this does not mean that the court can rewrite contracts.

The Supreme Court in Nabha Power Limited vs. Punjab State Power Corporation Limited & Anr. (2018) held that the court cannot override express terms of the contract with its own interpretation of the commercial intent. The terms included in the contract are final with regards to the intention of the parties. The multi-clauses contract must be interpreted in such a manner that a particular clause should not undermine any other clause.

The court further observed that given the negotiated drafts and exchange of emails between the parties before executing the Resort Management Agreement, the business efficacy test is necessary to discern the true intent to arbitrate. It added that dismissing three clauses in the Resort Management Agreement which talk about arbitration would be absurd therefore it is warranted to examine whether agreement makes more sense after applying the business efficacy test.

The court examined the correspondences between the parties which demonstrated that the parties initially referenced to arbitration in multiple provisions but in the final draft the arbitration clause was itself omitted. It was an oversight rather than an intention to exclude arbitration.

It further observed that section 7(4)(b) of the Arbitration Act envisages examining e-mail correspondence to discern an arbitration agreement and this is why examination of the e-mail exchanges immediately preceding the executed agreement point to the fact that the parties had originally envisaged arbitration, then wanted to give it a complete go-by, and then brought it back.

It further noted that when doing so, they missed out on one provision, rendering three provisions commercially absurd. This is why it is truly necessary to apply the business efficacy test.

The court concluded that “since it is not logical or commonsensical that arbitration would be reintroduced in the agreement merely marginally, without nothing special about the type of dispute covered by Section 23.3, in my considered opinion, the “penta test” is well met in the peculiar facts of the case.”

Accordingly, the petition was allowed.

Case Title: Lords Inn Hotels and Resorts Versus Pushpam Resorts LLP and 3 Ors.

Citation: 2025 LiveLaw (Bom) 60

Mr. Mayur Khandeparker a/w. Aman Kacheria, Rishabh Dhanuka, Ms. Anisha Didwania and Ms. Mahima Shah i/b. Agarwal and Dhanuka Legal, for Petitioner/Applicant.

Mr. Siddhesh Bhole a/w. Mr. Yakshay Chheda, Ms. Praharshi Saxsena, Mr. Approva Kulkarni i/b. SSB Legal & Advisory for Respondent No.1.

Click Here To Read/Download The Order